The FTSE 100 index leapt more than 23 points to 4,728.0, its second biggest one-day rise on record. It was the largest gain in prices since the recovery from the 1987 crash.
Meanwhile the pound slipped back from its overnight high of DM2.91 to end at just under DM2.89. Its index against a range of currencies fell by 0.5 to 101.6.
Pre-Budget speculation that the Chancellor, Gordon Brown, will deliver tax increases designed to dampen the budding consumer boom accounted for the stockmarket euphoria, analysts said. This would reduce the pressure on the Bank of England to cool the economy by increasing base rates again.
Steve Wright, at BZW, said: "This was the last thing you'd expect before a Labour Budget." But the market was reacting to rumours that Mr Brown would target consumers with higher taxes, he said.
Many experts have been calling on the Chancellor to get tough in his first Budget because rising interest rates have helped drive the pound to an uncomfortably high level.
But even as the financial markets concluded the "Iron" Chancellor would live up to his reputation by targeting the housing market and raising "green" and "sin" taxes, Britain's biggest mortgage lender warned that the housing market was not booming.
The Halifax reported that house prices climbed 0.7 per cent last month, to a level 7.1 per cent higher than a year ago. This was far tamer than separate figures from the Nationwide building society. The Halifax said: "There is no need for any specific Budget measures aimed at curbing an allegedly `booming' housing market."
The latest business survey yesterday, of purchasing managers in manufacturing, suggested that the strong pound has not yet harmed output or exports. But it has almost certainly hit profit margins on exports.
Peter Thomson, director general of the Chartered Institute of Purchasing and Supply, said: "It is encouraging that exports have not yet been hit by the pound. What is left of British industry is a good deal more efficient than it used to be."
But Robert Barrie, chief economist at BZW, said: "Right across the economy profit margins are under pressure. Companies are finding it hard to make money." Relief from the strong pound was urgently needed, he warned.
Most economists have been predicting modest tax increases, amounting to less than pounds 5bn, on top of the windfall tax on privatised utilities. Yesterday these expectations had clearly been revised up, with the City now expecting a rise in the tax burden big enough to make a material difference to the interest rate outlook. Analysts warned that the markets would fall in an equally dramatic fashion if these expectations were disappointed. "The stockmarket would be very disappointed if Gordon Brown doesn't deliver," said Mr Wright.
Peter Lilley, shadow Chancellor, told BBC Radio 4's World at One: "The only reason Gordon Brown wants to have a Budget now is to raise taxes so that he can tax more now to spend more later. That was always their plan. It has nothing to do with the state of the economic cycle and it's a mere pretence to cover up the age-old tradition of Labour coming in and raising taxes so they can spend more."
The Opposition parties' main pre-Budget challenge was concentrated on the Government's Welfare to Work programme, and the windfall tax that would be used to finance it. Stephen Dorrell, Tory spokesman on education and employment, challenged the Government view that the scheme to provide training opportunities for 250,000 under-25s could become self-financing, once it had been given a kick-start from windfall tax revenues.Reuse content